When was the last time you saw an ad or bought yourself a McDonalds hamburger for €1 or a t-shirt at H&M or Zara for €4,99…? Sounds like a great deal right?
But let’s be honest, if you take a moment and think about what goes into making a hamburger or a t-shirt, do you really think it’s possible to produce them for that amount?
The prices we pay for products and services is known as the market price, or retail price. And since most people haven’t studied economics, we’ll go ahead and say that most people will assume that the market price equals the production cost of something plus a profit margin for the seller.
At the moment, you can buy a Big Mac in the US for $5.65. However, back in 2013, the true cost of a Big Mac was calculated at $12,00. The true cost? Yes, because there are other expenses that are not reflected in the market price of a Big Mac.
Production and Capital
There are several inputs needed for the creation of a good or service, resources, inputs, or in an economic term: factors of production. Our current mainstream economy recognizes four: land, labor, entrepreneurship, and capital. Business theory prescribes that if you (as an entrepreneur) manage the factors land, labor and capital effectively and efficiently, this will ensure profitability and growth.
But as land, labor and capital are merely considered ‘resources’ in the production process, it can lead to quite a narrow view on how to optimize their effectiveness. Because this logic doesn’t take into account the dependency on the natural environment for land use and raw materials, nor does it appreciate a dependency on things like people’s general wellbeing, education and family structures that make labor possible (and seriously, can we call it something else than Human Resources). Business logic has separated itself from the reality of life.
Fortunately, back in the ‘90s, Forum for the Future developed its Five Capitals model, stating there are in fact 5 different stocks that organizations rely on to do business: financial capital, manufactured capital, social capital, human capital and natural capital.
Natural capital: the world’s stocks of natural assets which include geology, soil, air, water and all living things. It is from this natural capital that humans derive a wide range of services, often called ecosystem services, which make human life possible – 2017 World Forum on Natural Capital
Five Capitals Model
Businesses are dependent on all five of these factors for their ongoing success, and of course, these factors are all interconnected. If any business wants to be successful in the future, we need to focus on maintaining and continuously regenerating these 5 stocks, instead of depleting them as efficiently as possible in the name of productivity and production optimization.
Financial and manufactured capital (or the economy, if you will) form the inner circle and are embedded in the others. Natural, human and social capital are essentially the foundation of the economy and any business. In fact, without nature and society, there wouldn’t even be an economy in the first place.
When we start to look through the lens of the five capitals, we can see that currently, much of the capital that businesses rely upon for their success isn’t accounted for at all.
Recently, The Rockefeller Institute calculated the true cost of the entire food system in the US. And honestly, we thought these results were pretty shocking. The true cost of the US food system is $3.3 trillion per year. But Americans only spend $1.1 trillion. So that means the hidden costs in the US food system are $2.1 trillion per year. Even when we write that number in full (like this: $2.100.000.000.000) it’s still hard to comprehend just how much money that is.
True Costs: the regular production costs plus the hidden costs on society and the environment, minus the hidden benefits
There are health care costs in society to treat heart disease, diabetes and obesity, environmental costs from depleting natural capital through deforestation, carbon emissions, soil erosion, all related to current food production practices, and the meat industry for instance receives certain subsidies that are paid from taxes.
Hidden costs of the US food system
And currently, these expenses are not paid for by McDonalds, or all the other producers in the food system. Instead, these costs are hidden or externalized; generated by the producer but carried by society as a whole.
An externality is a cost that’s not included in the market price, and is a cost or benefit for a third party, who did not agree to it. It’s caused by a producer – who does not pay for the cost nor is compensated for the benefit.
But then who pays for these hidden costs? Well, ultimately you and me, through the taxes we pay to the government, or as we now see with biodiversity loss and climate change, it’s offloaded to younger generations for them to deal with it later. The problem is, the longer we wait, the bigger the problem will become. The costs will amalgamate and we’ll end up managing symptoms, instead of working on the root cause.
So, how might we make it better? Well, an obvious place to start would be the government, as they should be able to assess the effects of the externalized costs and hence mitigate the consequences.
One way of doing so is by regulation, as we’ve seen with the recent ban on single-use plastics, that will prevent millions of tons of plastic ending up in the ocean each year, a clear example of a cost that has been externalized for decades.
Another option is to introduce a tax to compensate for any negative effect, such as the ongoing conversation to put a price on carbon and introducing a carbon tax for companies. (Nerding out alert…: Imposing tax to mitigate externalized costs is called a Pigovain tax – named after Arthur Pigou, who first introduced the concept of externalities.)
Both these tools essentially seek behaviour change from the producer, discouraging them to cause the problem. But they are still enforced by a third party and don’t change the system from within.
True Cost Accounting
So wouldn’t it be much simpler if producers would be directly responsible for these externalities and start accounting for them?
Imagine there would be no more cheap plastic disposables, because the costs of pollution and biodiversity loss are factored in the price, making less damaging materials also financially more interesting. There would be no such thing as cheap clothes, because everyone gets paid a living wage and meat wouldn’t be cheap either, as the expenses of deforestation for land conversion or animal cruelty would have to be paid for directly.
This is where the discipline of True Cost Accounting comes in: identifying, categorising and quantifying, and where possible pricing all the different costs and benefits involved.
The idea is that when we have all these hidden costs transparent and we make producers accountable, they will then find ways to optimize and eliminate these costs, which means they would be producing more sustainably. Gamechanger!
“A product with a true price is sustainable, and if all products have a true price, the economy is sustainable.” – True Price Foundation
From a consumer perspective, putting true prices on products and services might come as a shock. Because for the record, yes, this would also mean a higher price at the checkout.
In fact, in February 2020, the world’s first true price store was opened in Amsterdam. For now, they only sell coffee (€3,50 + €0,25), chocolate (€2,79 +€0,90) and bread (€3,25 + €0,18) – as they’ve done the calculations for those products. We weren’t too shocked by these markups, but it turns out that so far, only living wage and climate change have been taken into account, so the true price is likely to be even higher.
And we’ve become so used to that €1 hamburger or a €4,99 t-shirt, it’s hard to imagine having to pay 3x, or even 9x as much. Yea, people won’t like it. And eventually, it probably means we will end up consuming less, make more thoughtful decisions around what we buy, and choose quality over quantity. Oh wait – that’s exactly what we need!
All in all, true pricing and True Cost Accounting are great tools to help us shift from a shareholder, profit-only perspective to a stakeholder-based, 5 capitals perspective. And that’s the transformation that needs to happen! Once you see this reality for what it is, we can get to work.
Are you already on the path of sustainable and regenerative business transformation, and ready to unleash lots of ideas and opportunities for innovation?
We love extensive stakeholder mapping to help businesses understand their interdependent relations in all the capital domains. And we probably mentioned it before, but we also suggest having natural capital represented in the boardroom, for instance through making Mother Nature your CEO.
And that’s just the start, as there’s so much more fun to be had! Upstream innovation, to figure out how to prevent a problem or cost like pollution from occuring in the first place. Or downstream; helping your customers to make better choices. And our favorite, looking at the core business model and value proposition, for instance by moving from a product-selling to a product-as-a-service proposition.
Give us a shout if you’re ready!
Minou & Pamela